Section IV: West Virginia Fiscal Forecast
By Mark Muchow, Deputy Cabinet Secretary, West Virginia Department of Revenue
The US economic expansion continued at a moderate pace over the past year even with headwinds from rising interest rates and higher than optimal inflation. The Federal Reserve Board (Fed) increased short-term interest rates by a significant 525 basis points through 11 separate rate increases spread out over a relatively short period beginning in March 2022 and ending as of July 2023. The Fed’s tighter monetary policies were contemplated to bring down inflation and to provide some slack in an otherwise tight labor market. After averaging less than 2 percent annual increase in the prior decade, general consumer price inflation began accelerating in early 2021 to a year over year peak level of nearly 9.1 percent as of June 2022. Subsequently, inflation levels trended lower over the past year toward an annualized rate somewhere between 3.0 percent and 3.5 percent. Recent inflation levels were still above the Federal Reserve target rate of 2 percent. Additionally, labor markets remained relatively tight with the unemployment rate edging up slightly from a low of 3.4 percent in April 2023 to 3.8 percent as of August 2023. As a result of a significant lag between short-term interest rate increases and their impact on the economy, the Federal Reserve recently paused further rate increase actions. Short-term interest rates were likely near a peak with still some chance of an additional future rate hike depending on whether tight labor markets yield significant upward wage pressure and inflation fails to further slow toward the 2 percent target rate.
For some perspective, in 2021 and 2022, commodity price inflation greatly exceeded overall inflation due to various demand-supply imbalances and due to political instability in Eastern Europe and elsewhere. The producer price index for energy jumped 70.7 percent between 2020 and 2022. Due in large part to the sharp rise in energy prices, West Virginia severance tax collections rose by 260 percent over a nineteen-month period beginning at the end of Fiscal Year 2021 to a record annualized peak of more than $1.08 billion as of February 2023. High energy prices also contributed to a one-year 16 percent jump in personal income tax receipts between 2021 and 2022 partially associated with higher natural resource royalty income payments, higher energy business profits and higher wage payments for the mining sector.
Energy prices declined significantly in 2023 from the high levels seen in 2022. A relatively mild 2022-23 winter season for both the eastern United States and Europe contributed to a bigger than expected build-up of natural gas inventories resulting in a trend of decreasing prices. Higher interest rates in the U.S. and elsewhere led to slower global economic growth. In addition, the Chinese economy experienced below average growth with continuing challenges from Covid. According to Natural Gas Intelligence, the average monthly price at the Eastern Gas Hub plummeted from a high of $7.89 per million BTU in August 2022 to $1.18 per million BTU in August 2023. Average West Virginia coal prices fell from a record high of nearly $149 per ton in May 2022 to an average of $104 per ton over the past quarter.
Despite significantly lower energy prices, West Virginia’s production of natural gas and coal both increased in 2023. According to the most recently published data from the U.S. Energy Information Administration (EIA), natural gas production through the first seven months of 2023 increased by more than 10 percent from the prior year to an annual pace of roughly 3.2 trillion cubic feet. Year-to-date coal production through the end of September was up 5.7 percent from last year with production at an annual pace of roughly 88 million tons. However, year-to-date West Virginia electric power generation as of July was down by 8.9 percent from last year, and coal-fired generation was down by 12.4 percent. Total U.S. coal-fired generation was down by more than 24 percent from last year through the first seven months of this year. Energy substitution associated with low natural gas prices was a contributing factor to the decrease in coal-fired generation along with a continuing trend of plant retirements. The coal industry’s market in West Virginia continues to gradually shift away from domestic sales toward foreign exports with more than 40 percent of production now destined for export outside of the United States.
The nominal value of foreign exports of West Virginia goods trended lower in recent months, mainly due to lower energy prices. The value of foreign good exports sourced to West Virginia fell 17 percent over the past year to $6.2 billion as of August 2023. The value of manufacturing good exports was up 12 percent, and the value of non-manufacturing exports, mainly coal, was down 44 percent. The decline in export value was due to lower prices as opposed to lower volume. The most recent data from EIA indicated a 30.1 percent decline in the price of metallurgical coal exports during the first half of 2023 along with a 6 percent increase in volume. Anticipated slower global economic growth in the near term and the growing appreciation of the U.S. dollar relative to foreign currencies both pose some potential headwinds for future foreign exports. However, EIA forecasts greater exports of energy products in the coming year.
West Virginia’s economic expansion continues in 2023 with growth in employment, wages, consumer sales and economic output. Payroll employment levels are rising at an annual pace of roughly 0.7 percent this year following a 2.2 percent increase in 2022. The State’s unemployment rate is near a record low of just 3.5 percent. Even though non-farm payroll employment remains roughly 1.7 percent below pre-pandemic levels, household employment levels have fully recovered. Wage and salary disbursement growth of nearly 7 percent is due to a combination of higher average wages and higher employment. Future wage growth is expected to gradually slow as inflation levels continue decreasing. Several new economic development projects, headlined by the multibillion Nucor Steel investment in Mason County, should add to the State’s economic performance over the next few years.
West Virginia General Revenue Fund collections totaled more than $6.48 billion in Fiscal Year 2023. Collections exceeded the Governor’s official revenue estimate by nearly $1.85 billion and prior year receipts by 10.1 percent. Official estimates for Fiscal Year 2023 were set to match the Governor’s proposed budget rather than actual economic projections. However, only 44 percent of the $1.85 billion surplus was attributable to the lower estimates. Following a 180 percent increase in Fiscal Year 2022, general revenue severance tax collections increased by an additional 23.1 percent in Fiscal Year 2023. Collections exceeded the unofficial estimate by more than $469 million and accounted for more than 25 percent of the Fiscal Year 2023 surplus. The 245 percent (i.e., $672.2 million) jump in severance tax collections over the past two years was largely due to significantly higher energy prices. In particular, the monthly average Eastern Hub natural gas price rose from a low of $1.03 per million Btu in November 2020 to a peak of $7.89 per million Btu in August 2022. Average coal prices also more than doubled within less than one year to a peak of nearly $150 per short ton in May 2022. Stronger than expected wage growth and consumption growth led to surplus personal income tax and sales tax collections collectively accounting for roughly 15 percent of the total revenue surplus. Wage growth was particularly strong in the energy sector of the economy. Income tax collections also benefited from inflated energy prices with a significant jump in royalty income and business profits. Corporation net income tax collections increased by an adjusted 59 percent over the past two years and accounted for more than 7 percent of the total revenue surplus. Record cash flow and higher interest rates contributed to a $126.5 million surplus in interest income, a factor accounting for nearly 7 percent of the total surplus.
In addition to the nearly $1.85 billion revenue surplus, the State closed out Fiscal Year 2023 with $156.8 million in unappropriated surplus from prior years and $26.1 million in expirations from Fiscal Year 2023 regular appropriations. The total unappropriated surplus including other minor adjustments was slightly more than $2.03 billion. A total of $231.6 million in surplus was transferred to the Rainy Day A Fund to bring the combined balances of the rainy-day funds up to the fulfilling statutory requirement of 20 percent of State appropriations.
The Legislature appropriated more than $1.16 billion of anticipated surplus in the Fiscal Year 2024 Budget Bill with the bulk of such appropriations associated with one-time infrastructure projects. Major surplus appropriations included $282 million for deferred capital maintenance at public universities, community colleges and correctional facilities; $125 million toward the construction of a consolidated laboratory; $52.9 million for Division of Natural Resource projects; $50 million for the National Cancer Institute at West Virginia University; $40 million for the School Building Authority; $38 million for the Water Development Authority; $37.2 million for economic development; $29 million for the West Virginia Osteopathic School; $21.06 million for soil conservation projects and $20 million for nursing education program expansions. The appropriation total also included a $400 million transfer to the Personal Income Tax Refund Reserve Account to further guarantee future budget stability.
During the August 2023 Special Session, the Legislature appropriated an additional $522.8 million of surplus, mostly for additional infrastructure projects. Major appropriations included $150 million for highway-related needs; an additional $125 million for a consolidated lab; $85 million to the Governor’s Contingency Fund; $45 million for a new cybersecurity program at Marshall University and $25 million for an aviation hangar at Pierpont Community and Technical School.
Strong revenue growth over the past couple years resulted in the implementation of a significant personal income tax cut effective in 2023. Governor Justice proposed a significant income tax cut during his State of the State address, and the Legislature subsequently enacted a multi-part tax reduction package. Effective January 1, 2023, personal income tax rates were reduced by 21.25 percent to the lowest tax rates in place since the current income tax was first implemented in 1961. The new Law also created future property tax credits beginning in 2024 against the personal income tax equal to the amount of local property taxes paid on qualified motor vehicles, qualified residential property owned by certain disabled veterans and up to 50 percent of the amount of qualified business tangible personal property taxes paid by qualified small businesses. The 21.25 percent income tax rate reduction was projected to reduce Fiscal Year 2024 revenue collections by roughly $700 million and Fiscal Year 2025 revenue collections by roughly $610 million. The higher cost in Fiscal Year 2024 was due to an implementation delay associated with legislation enacted in March 2023 that became effective as of January 1, 2023. The projected first full-year cost of the additional property tax credits was close to $200 million spread out between Fiscal Year 2025 and Fiscal Year 2026. The new law also contained a mechanism for possible future additional personal income tax rate reductions beginning as early as 2025. Future tax rate reductions of no more than 10 percent would be tied to the difference between actual General Revenue Fund collections minus severance tax collections and calculated inflation-adjusted General Revenue Fund collections minus severance tax collections. The initial calculation would be based on actual Fiscal Year 2024 revenues versus inflation adjusted pre-Covid Fiscal Year 2019 revenues. Any positive difference above inflation would equate to the dollar value of a future automatic tax cut.
The official FY2024 General Revenue estimate of $4.884 billion, developed in December 2022, is nearly $1.6 billion below actual FY2023 General Revenue Fund collections. The official FY2024 revenue estimate was designed to match the amount necessary to fully fund the Governor’s proposed General Revenue Fund budget for FY2024. An unofficial revenue estimate developed in November 2023 was nearly $400 million below actual Fiscal Year 2023 collections, mainly due to the expectation of significantly lower severance tax collections associated with lower energy prices and slower growth in income taxes. These estimates did not incorporate any significant tax changes in the absence of a final plan agreeable to all policymakers at that time. After full accounting of the 21.25 percent personal income tax rate cut, Fiscal Year 2024 collections are still projected to exceed the Official estimate by at least 6 percent. As a result of conservative budgeting and conservative revenue estimates during a period of unusual turbulence, West Virginia’s finances are well positioned despite the prospect of slower economic growth in the near term associated with higher interest rates, above target inflation and geopolitical turmoil.
The base budget appropriations for FY2024 General Revenue and lottery revenue are $5.47 billion, $269 million more than the base budget appropriations included in the Fiscal Year 2023 budget of $5.2 billion. The increase in base budget reflects salary enhancements of nearly $120.6 million, over $21 million in additional funding for corrections, $5.6 million in additional higher education funding and roughly $611 million in unanticipated one-time infrastructure-related appropriations.
The basis of the current budget outlook for FY2024 and FY2025 is a forecast of a slower rate of expansion in the State economy due to the impact of higher interest rates, a gradual but uneven slowing of overall inflation rates and some anticipated decline in coal production during the forecast period. The highly uncertain energy sector outlook has great bearing on the future direction of State revenue collections. At this time, natural gas prices are expected to rebound above current levels over the coming year with additional benefits associated with the completion of the Mountain Valley Pipeline. Following production gains in 2023 associated with inventory replenishment, coal production is likely to decrease over the forecast period with much greater reliance on foreign exports for future sustainability. In this climate, revenue volatility will remain above average over the forecast period.
West Virginia remains fiscally strong due to conservative budgeting and conservative revenue estimates during this time of uncertainty. The State is also positioned to handle the coming transition toward lower future federal funding available for State government service needs. The current positive gap between revenues and expenditures should largely dissipate over the next couple years as tax cuts reduce incoming revenue and cost pressures, mainly associated with healthcare and corrections, increase expenditures.